Companies in their earliest stages face a lot of challenges. Legal challenges are certainly among the most important. However, with professional legal guidance these fundamental legal issues can be handled in a way that sets up the new company for future success. So, what are some of the legal issues should entrepreneurs and founders address?
1. What Kind of Company to Create?
In order to mitigate personal liability and to create a vehicle for investors, most founders choose to incorporate as a C-Corp (think standard corporation). Obtaining venture capital for other forms such as an S-Corp or Limited Liability Compnay is nearly impossible. Just as important is where you choose to incorporate. Delaware is among the most popular place to incorporate for many reasons, including demonstrating seriousness of intent and because nearly all corporate attorneys understand Delaware law regardless of where they are located. In addition, you will be held to the legal and tax codes in the jurisdiction in which you choose to incorporate. Find a professional in the area who can explain your options and then execute the plan.
2. Founders Equity and Employee Stock Options Plans
Startup companies have to deal with both founder's equity and employee stock options plans (ESOPs). Implementing an ESOP and/or restricted stock offering gives your employees a stake in the success of your company, thereby giving them incentive to make a long-term commitment to the success of the company and rewarding them for their contributions. There's also the issue of founder's equity. While an even split might sound like the most fair arrangement, it will likely lead to problems down the road and could potentially be a red flag for investors. Founders equity should vest over three or four years to demonstrate commitment to future investors.
3. Employee and Consultant Agreements
Necessary standard legal agreements include confidentiality agreements, non-compete clauses (in states where they are enforceable), and assignment of intellectual property including inventions for both employees and consultants, if any. When starting a new company, it's advantageous to have these and other typical agreements in template form. Many law firms who work with startups have “starter kits” which include these and other documents that can be customized to the particulars of the new company and its founders.
4. Patents -- Provisional, Utility, and Design Patents
For product companies, especially those selling to the consumer market, design patents cover the look (ornamental design) of the product. A provisional patent is a way to get something on file at the US Patent Office that when done well, documents what the company knew and when it knew it. America has gone to a “first inventor to file” regime and it’s important to get to the patent office first. Within a year of filing a provisional application, the inventors or startup should file a utility patent application which will be examined by the Patent Office to determine if a patent should be granted. There is a lot of complexity and inventors and startups are well advised to get help from a patent attorney registered to conduct business with the US patent office.
5. Trademarks and Copyrights
Web and mobile based businesses especially should discuss trademarks and copyrights with an attorney whose legal practice is focused on one or both of these areas. Copyrights can be used to protect, for example, software and the content of mobile applications that is displayed to the user. Trademarks can go along way to protecting the brand and distinctive ways in which the brand is used, for example words or words and typefaces and graphic elements. Trademark searching to make sure no one else is using the mark for a similar business is often expensive. One can do a lot using Google and other search tools and then have an expert do a broader search in conjunction with a first round from professional investors.
Companies in their earliest stages have a great deal of legal matters to consider. This list of 5 highlights should be addressed early on to lay a foundation for growth, success, and for working with angel investors and VCs. To learn more, please come see our panel of experts speak on these and other critical legal issues at our December 6th event.